A market and portfolio update in a challenging environment

James McManus


4 min read

The world economy is facing its greatest challenge in a number of years as the coronavirus outbreak and a sharp fall in the oil price rattle investment markets. In this blog we explain how we’re responding to the events.

Financial markets remain incredibly volatile this week, as investors digest the effects on economies, businesses and the consumer of fast-moving news on two main issues: the coronavirus Covid-19 and the oil price.

The slowness of response in some nations to Covid-19, which has recently spread outside of Asia, has caught financial markets off guard. Efforts to catch up are now accelerating, but uncertainty remains over the level of disruption that may be required for containment to be effective. Meanwhile, a sharp drop in the oil price has introduced a further supply and demand shock (however, falling oil prices are not necessarily a negative story).

Policymakers are acting to provide support during this temporary disruption

On 11 March, the Bank of England acted decisively by cutting interest rates by half a percent and announcing measures to help businesses navigate the current environment. The UK Government also revealed a large government spending package and vowed to support the health service and economy, whatever it takes.

We continue to expect a global acceleration in three types of policy: medical policy response; fiscal policy, consisting of government spending and taxes; and monetary policy using interest rates and emergency lending.

We expect the message to echo a critical point: that policymakers the world over recognise the disruptive potential of the disease but are committed to supporting their economies through this temporary disruption.

How are Nutmeg portfolios positioned?

It’s worth remembering that a core principle underpinning all Nutmeg investment portfolios is diversification. Our investment team seeks to build portfolios that are invested across global financial markets, allowing us to spread the risk across a broad range of countries, economic sectors and companies.

In our fully managed and socially responsible portfolios, our investment team make strategic adjustments to the investment strategy over time to reflect the prevailing medium-term economic outlook. As such, our fully managed and socially responsible portfolios currently hold lower allocations to risky assets, such as equities and higher yielding corporate bonds, than they would be expected to hold over the long term.

We have maintained our long-term level of exposure to government bonds, typically seen as some of the safest investment assets (bonds tend to gain when there is market volatility). However, we have ensured these positions don’t grow too large by trimming the gains where appropriate.

We also currently hold much more cash in portfolios than we would expect to hold over the long term. From time to time, cash can be a useful asset in portfolios. Our holdings reflect our cautious near-term outlook, the fact that government bonds have become expensive relative to their own history, and our preference to allow us to be responsive as events develop.

What does history tell us about the path ahead?

In times like these, it’s easy to allow the relentless news cycle to play havoc with our emotions. However, the best investment strategies always consider objective facts instead of allowing behavioural biases to take hold.

No one has a crystal ball, but we can look to the past to inform how we approach the current scenario. Some stock markets have now fallen 20% since their peak. A 20% drawdown in the value of an equity index is – by convention – recognised as the end of an equity bull market.

That’s a significant fall, but it’s worth noting that Nutmeg portfolios are much more diversified than a single stock market index – typically they contain a range of assets such as bonds as well as stocks. That means a range of performance outcomes for Nutmeg portfolios would be expected, depending on the risk levels of each portfolio.

We can use a mid-risk portfolio to gain some useful perspective based on past market events. A Nutmeg globally diversified fixed allocation portfolio at risk level “balanced” (equivalent to 3 on a five-point scale), for example, has fallen by about 10% since the recent market peak. Let’s look at some historical data to see what has happened in the past when this kind of portfolio has fallen this much. In fact, let’s make the example more extreme and look for events where this type of portfolio fell by 15% or more.

In the following chart, the high-water mark (orange line), shows the highest peak achieved by the portfolio before each fall. There were three events since the mid-1990s in which the performance fell by 15% from the previous peak (grey vertical lines) in the chart below.

What’s important is what happened after the falls. In the 12 months after each fall, the average return across all three 12-month recovery periods was about 10%. After 24 months, the average return across the three comparable periods was 24%.

 

Source: Nutmeg calculations based on simulated performance 30/06/95 – 12/03/2020

 

In the long term, patience is rewarded

It’s an important reminder that, yes, investing is a risky business. But the patient, long-term investor is rewarded for not only remaining invested but, very importantly, for continuing to make contributions into their investment funds during periods of volatility.

Update to Nutmeg portfolio positioning, 13 March

Disappointed by the US medical and fiscal policy responses to Covid-19 and the lack of global policy cooperation, the investment team reduced risk in fully managed and socially responsible portfolios this week. We have taken the opportunity of a Friday market rebound to rebalance allocations by lowering our heavy US overweight exposure in higher risk portfolios. Overall equity underweights are now consistent, at about 10%, in mid-to-higher risk portfolios. We have also continued to trim all portfolios’ exposure to high yield bonds, which embody a significant level of cash-flow-disruption risk.

We have moved these allocations to cash. This is a highly unusual move that reflects our disappointment at the global medical and fiscal policy response by governments. We continue to believe that the disruption of the virus will be temporary, but the evidence of recent weeks is that financial markets are unwilling to give governments and policy makers the benefit of the doubt during this period of uncertainty. We stand ready to reinstate more risk in the portfolios if policy responses, particularly in the US, are clarified.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.

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James McManus

James is chief investment officer at Nutmeg, having joined in 2015 from Coutts & Co. A self-confessed ETF geek, James is regularly quoted in the national and industry press and has been voted one of Private Asset Manager’s ‘Top 40 under 40’ in each of the last three years. James holds a BSc in International Business from Nottingham Business School, the CFA UK Investment Management Certificate, and the CFA Certificate in ESG Investing. He can be found tweeting @j_a_mcmanus


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